C Corporations: Double Taxation Now Less of a Concern
In the past, with a tax rate of 35%, C Corporations were usually not a favorable option for tax purposes when choosing an entity. At that time, for a corporation to pay tax at a rate of 35%, then the shareholder to pay a 20% tax on the dividend, would cause an effective tax rate of 48%. On the other hand, if the taxpayer chose a passthrough entity such as an LLC, the highest individual rate was only 39.6%. Therefore, the double tax of the corporation was much higher than the tax paid on a passthrough entity. This difference was even worse when considering the individual long term capital gain rate of 20%.
Now, with the lower corporate tax rate of 21%, the effective tax rate drops to below 37%, which is almost the same as the highest individual rate of 37%. Even when compared to the long term capital gain rate, the inside corporate rate of 21% is nearly the same as long as the corporation does not immediately pay the dividend. Additionally, choosing to not immediately pay the dividend impacts the difference in effective tax rate on ordinary income. Paying the corporate rate of 21% for several years, and then paying a dividend at 20%, will be much better financially than paying the full 37% each year. This illustrates one of the most important factors in tax planning – cash flow. When investors can leave the income inside the corporation to enjoy the 21% rate year after year, it will have a major effect on the choice of entity decision, as opposed to an investor that needs the cash on a yearly basis.
There are other factors to consider, such as the deduction for qualified business income, which is available to some passthrough entities. This deduction can make the corporate rate less favorable, but it does not apply to all businesses and has limitations. Overall, there are many factors to consider, including non tax factors; however, with the lowered corporate rate it is important to consider a C Corporation even with taxes in mind.